Oakland’s losses are due most likely to interest rate swaps the city agreed to with several banks in the mid-2000s. In 2004 Oakland sold $117 million in variable rate bonds. The underwriters of these bonds, Bank of America and UBS attached interest rate swaps to these variable rate bonds. The swap payments involved a two way flow of funds between the city and the banks that was intended to convert the variable rates on the bond debt into a “synthetic” fixed rate.

Under the terms of the two deals with Bank of America and UBS, Oakland paid the banks 3.533 percent, and in return the banks paid 58 percent of the 1-Month LIBOR rate, plus a “spread” of 350 basis points (0.350 percent). The LIBOR-linked rates the banks paid Oakland were intended to mimic the variable rates on the bonds, thus passing through Oakland to service the bond debt, leaving Oakland paying the fixed rate of 3.533 percent (thus the “synthetic” label).

However, because UBS, Bank of America, and other banks that were part of the panel that set the different LIBOR rates, rigged LIBOR downward over various years, Oakland ended up paying more than it should have. It was theft, plain and simple, even though it occurred through a complex financial architecture invisible to most.

To assess just how much money was stolen from Oakland by UBS and Bank of America we must determine when, and by how much the banks manipulated the rates, and in what direction. Financial analysts employed by many local governments and public agencies are currently doing this tedious work, including inside Oakland’s finance and legal offices.

To help the public understand how the conspiracy worked, and just how much it may have affected Oakland, I’ve calculated the following guesstimate.

Let’s assume that since 2004 the banks rigged the LIBOR rate downward by an average of 50 basis points at any given time. This is a really sloppy and imprecise assumption as the banks might have rigged the rate upwards and downwards over time depending on what rates would have benefitted them in the ever-shifting world of finance. Rigged rates could have been jacked up a lot during some periods, while only a little bit during other periods, or downward by big and small margins. For the sake of simplicity let’s just assume the average impact of the LIBOR rigging conspiracy over the terms of Oakland’s swaps with UBS and Bank of America was negative 50 basis points, or -0.05%.

The following table shows what Oakland probably actually paid between 2004 when the swaps were signed, and 2008 when the city terminated the swaps (they were originally intended to run to 2026). Assuming the LIBOR rate wasn’t rigged would mean that after netting out Oakland’s fixed rate against the bank’s LIBOR-linked variable rate, Oakland paid the banks approximately $7.7 million.

If LIBOR during this period was skewed on average by negative 50 basis points by the banks, it would mean that the variable rates paid by the banks to Oakland were lower. Under this scenario the net flow of payments would have been even further in the favor of the banks. The following table adds fifty basis points back to LIBOR, simulating what the banks should have paid in the absence of the conspiracy. Under this hypothetical scenario the banks should have only received $7.45 million from Oakland.

The difference of a quarter million here is the amount that the banks might have stolen from Oakland.

Then there’s the termination payment that would have been made in the Spring or Summer of 2008 by Oakland to close out the swaps. These termination fees are calculated using the “fair value” of the swap. The swap’s value depends on where LIBOR is at, and where it’s trending. Thus if the banks had been rigging LIBOR downward over time, and pressing down very aggressively during the financial crisis, Oakland’s termination payments would also have been skewed in the favor of the banks. So an estimate of $300,000 seems to be a reasonable, if conservative, estimate of how much was stolen from Oakland by UBS and Bank of America.—Pueblo Lands – Political economy from the San Francisco Bay Area and Beyond

ISDA Master Agreement

The ISDA master agreement is the most commonly used master contract for OTC derivative transactions internationally. It is used to govern many of the financial transactions between the City of Detroit and Wall Street. Below are links to the agreement and sites with explanations.